Futurist marketing consultant Faith Popcorn once said, “you can trust a crystal ball as far as you can throw it.” And as Laurence Peter, who formulated the Peter Principle of management, famously quipped: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”
You don’t need a crystal ball, tea leaves, tarot cards or a subscription to The Economist to know interest rates are set to rise around the world as inflation levels reach decade-long highs. And with those central bank and trading bank hikes in the cost of borrowing will come rises in mortgage rates that most people who have just bought their first home will have never experienced.
By far the biggest driver of the current housing boom have been first-time buyers who have only known ever-escalating property values and plummeting interest rates.
It’s a fact that every tightening cycle for the last 40 years has seen a lower ‘low’ and a lower ‘high’ in interest rates. This structural change has been seen worldwide.
Even though in our lifetimes we may never go back to the 9% rates of 2007, people are still going to suffer the mortgage servicing pain that their parents went through — the rates of borrowing may be much lower but because house prices are so much higher, they’re going to be much more indebted than previous generations.
Earlier this year, an ANZ economist calculated a 1% rise in mortgage rates would cut the disposable income of Aucklanders by 5% and of the rest of us by 3%. Already we’re well on the way towards realising this scenario.
The Reserve Bank raising the OCR for the first time in seven years triggered a chain reaction that led to not only banks hiking their interest rates but also impacted financial markets via everything from soaring 10-year government bonds to sizeable increases in wholesale swap rates, which have a large bearing on what banks charge borrowers.
Headline Consumer Price Index inflation is expected to top 5% in the short term because of higher oil prices, rising transport costs and the impact of supply shortfalls.
Wherever you look, the cost of living is rising, from the price of petrol to a block of Whittaker’s chocolate to a Netflix subscription.
While the Reserve Bank reckons “measures of core and medium-term inflation expectations remain close to 2 percent”, that’s of little comfort in the meantime if, as one bank economist has predicted, inflation tops 5.8% early next year, and the OCR rises to 2%.
Everyone expected the Reserve Bank to raise the OCR and they have, twice, by 0.25 points, but the hawkish rhetoric caught many of us off-guard.
First-home buyers don’t hang on every word the Reserve Bank governor says but they are well aware of what’s happening with the interest rates banks charge, especially when they were raising these ahead of the OCR increase. It would be fair to say, based on our anecdotal evidence, that these buyers are rattled by the turn interest rates have taken and are now doing their sums on much higher rates than when the housing market was really humming.
It’s true that banks have been more rational with their lending, and mortgages have been harder to get. But this hasn’t stopped property prices from surging 30% in the last year – an almost unheard of rate of increase.
There’s still been excess demand over supply, which means mortgages are being approved despite the tougher lending criteria. Otherwise, the market wouldn’t have been so strong.
Back then, however, buyers were factoring in a 2.5% interest rate, almost in perpetuity. But now, with interest rate rises here and more on the horizon, behavior is changing. There’s a big difference between servicing a million-dollar loan, even with two decent incomes, when the cost of borrowing virtually doubles.
For people who bought houses in the late 1980s, when interest rates were around 20%, 4% or even 5% may not sound a big deal. But it’s the percentage increase from such a low base that affects affordability and, ultimately, the psychology of the marketplace. It’s a dramatic change and marks a significant turning point at a time when the market was already slowing. Our own most recent quarterly data shows buyer activity in Wellington has roughly halved year-on-year.
Now that people realise that low interest rates aren’t here forever, their expectations of the future are changing. For the first time they could be facing a period of flat or declining prices and rising interest rates. As a real estate agent, you might think I’d be the last person to be talking down the market rather than talking it up. But it would be wrong not to acknowledge the reality of what is happening, in the hope people can make more informed buying and selling decisions as a result. None of this is to suggest there’s going to be a big market correction overnight. Indeed, we’re more likely to see fewer sales than a significant fall in prices.
A key indicator is stock levels. As the daysto- sell starts to grow, some houses won’t sell, which will increase the supply of houses at any one time. We have seen the amount of homes for sale in Wellington City rise from 330 four months ago, to about 650 at the time of writing. Even adjusted for the seasonality this shows that some properties are already taking longer to sell. In the GFC, there was a 10% decline in property prices but turnover went down 40% because people just don’t sell if they can’t get their price, and if they’re sitting on negative equity, banks won’t let them sell anyway.
Selling a home is usually a lifestyle decision but is sometimes needs-based. Needs-based sales will always continue, for reasons of health, work or family, but sales for lifestyle reasons can stall when vendors, anchored to a high price, decide they will stay put instead of accepting the market price.
It is important to remember this when selling your home. Right now, nearly everyone selling will make a gain. But some people will still make poor decisions. Think of it this way: even if the price you receive is 5% lower than your expectations, after a 30% rise in the last 12 months, the house you would have sold for $1,000,000 just last year will still sell for well above this — but it may be for $1.25 million instead of $1.3 million. The most rational way to look at this would be to be happy about a $250,000 tax free capital gain in just 12 months. But psychologists have shown that people are affected far more by a perceived loss than a gain. “Loss Aversion” as it is known, is so powerful, people would even put on hold all their future plans, just to avoid feeling like they did not “lose” the last $50,000 gain, even if it means not realizing the other $250,000 profit. We are all affected by these biases to some degree, but if we try to be self-aware, we can make better decisions.
Moving into 2022, my best guess is that we will start to see overall stock levels continue to grow as sales volume goes down, and buyers’ expectations change. Not just because of higher servicing costs but also less urgency — there won’t be the same fear-of-missing-out that’s motivated buyers, and with prices not rising as fast, there will be less demand.
No one can predict the future but if you are considering a move, and you want to capitalize on what’s happened in the last 12 months, selling before the media gets hold of Wellington sales data, and starts to ramp things down in the same way they ramp things up, is probably a good idea.
No matter what happens with supply and demand in the short term, the value of your house will still be significantly above what you would have sold it for last year.